China is the world’s second largest digital economy, second only to the United States, and leads the world in the value of many digital applications, including e-commerce and mobile payments. This extensive online activity by Chinese netizens also provides huge amounts of data that can be used to train artificial intelligence (AI) algorithms. China’s dominance in 5G infrastructure will further support China’s digital economy and early 5G rollout in China could give Chinese entrepreneurs a head-start developing new digital applications. China’s digital economy and the importance of data and digital services is also intertwined with its manufacturing activity and the centrality of China in global value chains (GVC), providing enormous scope to export digital services as inputs in manufactured products.
Yet, China remains largely closed to foreign competition, with restrictions on digital services imports, a heavily restricted and regulated internet that requires data to be localized, and limited access to online information. These limits to foreign competition stand in contrast to China’s outward focused efforts to shape the international environment and the development of norms and rules affecting data governance consistent with its domestic approach. This includes in international standard-setting bodies, through its support for broadband connectivity and smart cities as part of its Digital Silk Road (DSR) and broader Belt and Road Initiative (BRI).
These Chinese efforts abroad and restrictions domestically are harmful to U.S. interests. The United States has been leading efforts supporting an open internet, particularly through its development of digital trade commitments and support for similar efforts in the G20 and Organisation for Economic Co-operation and Development (OECD). However, more is needed to effectively counter China’s efforts globally including as part of its DSR, or risk an internet bifurcated between the United States and China, with security and economic consequences for the United States and its allies.
How big is China’s digital economy?
China’s digital economy is large and growing. Based on an OECD taxonomy, Figure 1 shows that China’s digital economy was around 6% of gross domestic product in 2018, compared to around 7% in the United States, 8% in Japan, and 10% in Korea.
However, in absolute terms China has the world’s second largest digital economy, second only to the United States. Moreover, China has particular digital strengths. For example, China accounts for 40% of global e-commerce transactions, larger than the value of France, Germany, Japan, the United Kingdom, and the United States combined.2 The transaction value of China’s mobile payments in 2016 were $790 billion, 11 times that of the United States, the next largest market. When it comes to AI, China overall trails the United States but leads in specific applications such as facial recognition.3 This range of digital activity drives extensive online activity that generates enormous quantities of data that can be used to train AI algorithms.
Digital services, data, and manufacturing
Much of what drives China’s digital economy — the data and key digital technologies — are digital services. In fact, the digital economy is largely about digital services, and includes cloud computing, AI, blockchain, and data analytics to derive better business insights, manage supply chains, and enable digital payment, as well as the online delivery of professional services, retail, education, and healthcare.
Understanding the scope of China’s digital services exports needs to account for the role of digital services as important inputs into manufacturing exports. In some areas of manufacturing such as automobiles, the digital services component (including software, sensors, and AI) provides much of the value add and is where competition is most fierce. In fact, McKinsey estimates that by 2030 up to 30% of automotive manufacturer’s revenues will come from services offering.4 China’s growth in using digital services in manufacturing is part of a broader push by China into advanced manufacturing, which includes leading the world in its use of robots, where China holds one-third of global stock, over twice that of the United States.5
Chinese companies are also dominant in the supply of 5G hardware, which will also affect growth in data driven services. By one measure, Huawei owns the largest share of standard essential patents on 5G.6 5G will bring high speed connectivity to the edge of the network, reducing latency and increasing speed.7 This will enable the internet-of-things (IoT) and edge computing, and support a range of new applications, content, and businesses such as augmented reality and autonomous delivery systems. Cisco estimates that the number of devices connected to the internet will be 30 billion by 2023, half of these being machine-to-machine connections, including connected factories, home devices, and cars.8 5G will also impact the development of global value chains and the role of digital services as 5G and associated technologies expand the capacity of business to collect data from things in real time, analyze the data, and develop business solutions along supply chains.9 5G will affect Chinese growth in digital services. In part as China rapidly installs 5G domestically, Chinese entrepreneurs will have a head-start over their Western competitors developing new data-driven business models that 5G will enable with opportunities to get to market first. And where network effects create winner-take-all outcomes, potentially new and dominant tech companies.
China’s digital services in GVCs
China is also expanding its digital services exports and data governance more generally through its role as a central hub in GVCs and the BRI.
China is a central player when it comes to information and communication technology (ICT) goods exports as part of global supply chains. For instance, China accounts for 32% of global ICT goods exports (11% in value added terms — reflecting China’s position in GVC), and around 6% of ICT services exports. However, these figures understate the importance of China’s digital services exports as it fails to account for services as value added inputs into manufacturing and export — often in the context of GVC.10 This growth of services in manufacturing GVC has contributed to services exports growing faster than good exports.11 The World Trade Organization (WTO) estimates that services account for 30% of the value of China manufactured exports in 2015, which is a 19% growth in services value added since 2005.12 The trends toward using services and data in GVC point to the broader servicification of manufacturing, another development that China is driving and is well positioned to take advantage of.13
The digital dimension to BRI
China is also expanding its digital services and approach to data governance through the development of a Digital Silk Road (DSR), which aims to expand internet infrastructure, promote e-commerce, and develop common internet technology standards amongst participating countries.14 China’s March 2015 white paper made digital connectivity a top priority. As of 2019, China had invested over $80 billion in digital DSR projects, including fiber optic cables. China is also building data centers, which Beijing has called a “fundamental strategic resource.”15 These developments are integrated with other BRI initiatives, including smart cities, ports, and space systems.16 Each of these developments creates new opportunities for China to expand access to data and integrate DSR countries into a broader digital ecosystem centered around China.17
China’s governance of digital services and data
China’s regime for governing digital services and data is based around a relatively closed domestic market for digital services alongside restrictions on cross-border data flows, including access to information. This closed market helps underpin Chinese support for national champions. Including by preventing access by Chinese citizens to their U.S. competitors. The extent of Chinese control over data and access to information led former Google CEO Eric Schmidt to foresee the single global internet bifurcating into a U.S. and China led internet.18 This could also include different standards and frequencies for 5G. Indeed, both the United States and China have identified leadership in 5G standards as a key element to securing their version of 5G.19 The risk for the United States of a bifurcated internet is further heightened by China’s efforts to shape the international environment to support its vision of data governance and digital services exports.
Restricted domestic market for digital services
China maintains a relatively restricted market for digital services. The OECD digital services trade index in Figure 2 shows barriers affecting trade in digitally enabled services categorized into five policy areas: infrastructure and connectivity, electronic transactions, payment systems, intellectual property rights, and other barriers. The higher the score, the greater the restrictions. As can be seen, amongst the countries listed, China is most restrictive when it comes to digital service across all metrics. China is also most restrictive when it comes to telecommunications services.20
Figure 2: China’s digital services trade regulation are the most restrictive21
These restrictions are parred with domestic policy aimed at dominating emerging technologies. This includes industrial policies such as the National Medium and Long-Term Science and Technology Development Plan Outline (2006-2020) which calls for China to become an innovation-oriented society by the year 2020 and a world leader in science and technology by 2050, based on developing capabilities for indigenous innovation. The “Made in China 2025” initiative launched in 2015 — a 10-year plan for China to achieve 70 percent self-sufficiency in strategic technologies such as advance information technology, robotics, aircraft, new energy vehicles, new material, and biotechnology. Similar industrial policies are also being implemented at the sub-central government level.22
Restrictions on cross-border data flows
China also employs the most extensive restriction on access to and use of data, including data localization requirements and restrictions on movement of data across borders, further restricting opportunities for digital services trade. Figure 3 below shows the number of data flow restrictions and compares that with other economies within the Asia-Pacific Economic Cooperation (APEC).
China’s most restrictive cross-border data flow regulations are around security, internet access, and control and financial flows and services. Such data flow restrictions include China requiring banks and insurers to localize data and China’s data localization requirements under its cybersecurity law. In addition to restricting data flows which affects access for digital services, these regulations could be used to require access to companies source codes and intellectual property under the guide of national security, which could be used by Chinese companies to compete against U.S. and other companies.23
Shaping the international environment to suit Chinese interests
China is affecting the market for digital services and the uptake globally of Chinese data governance practices by influencing international norms and rules and by creating facts on the ground, such as by leveraging the DSI and access to China’s internal market.
A key area where China is working to develop rules and norms that will affect growth for China’s digital services trade is by shaping international standards to suit Chinese companies and technologies.25 Chinese companies and officials engage across standards setting organizations and forum, including 3GPP (3rd Generation Partnership Project) which is responsible for 5G standards and in the International Telecommunications Unions (ITU), where China is working to develop standards that suit its technological ambitions, such as in areas of facial recognition26 and IoT.27 This includes placing Chinese officials in senior positions in the ITU and supporting participation of Chinese engineers in technical working groups.28 Chinese specific standards are also being normalized through the DSR as investments in connectivity, smart cities, and data centers which come with Chinese standards.29
How should the United States respond?
The United States has already responded in part. It is developing new digital trade rules in free trade agreements (FTAs) supporting the free flow of data and further services trade liberalization. The United States is also pushing for data flow commitments in the WTO e-commerce negotiations.30 In the G20, the United States has worked with leaders on statements on data flows and digital trade, yet these G20 outcomes have been limited by G20 members China, India, and Russia.31
The United States continues to work on developing international standards. As noted, however, the strategic engagement by China with international standards bodies, including the resources China brings to bear, suggests the United States needs to revisit its approach to standard setting, including allocating increased resources and political capital to ensure that international standards are technically optimal and support open and competitive markets.
U.S. efforts to address Huawei’s engagement in 5G are well documented. Tom Wheeler has suggested another way of addressing Huawei’s proprietary edge in 5G equipment is to support open standards for 5G.32
The United States is also working with allies on broader data governance issues around specific technologies, such as through the Global partnership on AI and developing OECD principles on AI. These efforts strengthen normative expectations that markets remain open and competitive.
However, more is needed from the United States. Any approach to addressing the challenges China presents on digital services trade and data governance will require a coordinated approach with allies as well as more attention domestically to the regulatory issues that drive data flow restrictions.33 On the international front, the United States should work with like-minded countries on a comprehensive approach to data governance that could also draw in market access issues around data flows and access to digital services. This could involve some combination of more robust common international standards and development of interoperability mechanisms that support data flows and achieving domestic regulatory objectives such as privacy and cybersecurity.34
In parallel, the United States needs more comprehensive domestic regulation on various data and tech issues, particularly federal privacy regulation. This is needed to address concerns amongst allies, especially the EU with respect to online privacy. Progress here could lead to better alignment and ambition amongst U.S. allies on other U.S. data governance priorities. More broadly, the traditional reliance of the United States on industry self-regulation has left the U.S. government with an absence of robust regulatory models around data governance that can serve as a guide to other countries looking to understand how to shore up trust in online activity while also benefiting from the economic and trade opportunities of cross-border data flows. The lack of any such U.S. regulatory models has provided space for China’s approach to gain traction, puling these countries closer into the digital sphere that China is carving out for itself, including all the concomitant emphasis on data restrictions and data localization that act as barriers to trade in digital services.